QUANTITY THEORY OF MONEY
Meaning: * Doub,
Half the quantity of money an
\d other things he:
before and value of money doubler NIMES being equa Price will be
one half of what they
Two types of approaches: ( gj
Cash transaction approach:
Fisher equation of exchange-
PT=My
or P=MWT.
M= Quantity of money
T = Total amount of transaction (total trade or amount of goods & services to be
exchanged )
V = Number of times a unit of mone;
used five times for exchange of goods ani
considered. As (5)
'y changes hands during a year E.g If single rupee is
di services during a year then its velocity will be
Validity through an example:
Assumptions:
1. There will be full employment of the resources to produce goods & services.
2. Velocity of money depends upon the taste and habits of people which will remain
unchanged
Criticism by Keynesian Economists:
1. Output will not be constant in long run,
“
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eee7 sification — With increase in supply of money interest rate will fall and with more
noney producers will increase their capacity to produce by finding di n
available to them, y finding different alternatives
Les
2. Velocity will not be constant in short run,
Justification - With i i
as sy = increase in supply of money people ty to hold extra money which
Eee velocity of money in circulation which offsets the effect on prices of
‘goods and services with increased supply of money
Cash balance Approach (Marshall, Pigou & Keynes)
tum of exchange function only
It focuses on store of value function of money rather than medi
{f nominal income in form of
(fisher). According to it people would like to hold a proportion of
money (Cash balances). They assume it
In equation form :
Md=kPY
Y= Real National Income (aggregate output)
P= Price of goods and services
Md = Money demanded
In order to achieve equilibrium
Md = (Quantity of money supplied)
Therefore ,M= «PY
OrP=1/k. MIY
Validity through an example:
Assumptions:
1. There will be full employme
2. Proportion of nominal people kept in o
nt of the resources to produce goods & services
der to fulfil their needs will remain constant
Criticism :
1. Output will not be constant in long run.
Scanned with CamScannerJustification — With increase in supply of money interest rate will fall and with more
money producers will increase their capacity to produce by finding different alternatives
available to them.
2. K will not constant in long run.
Justification - proportion of money people want to hold changes in the long run when
they see the prices are going high
Similarity between both approaches:
1. Both assumed employment of resources to their full capacity.
2. Velocity and k are two sides of same coin.
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